PubFinCriteria_2006_part1_final1.qxp

■Acceptable additional termination events, including

maximum rating triggers;

■Use of insurance or collateral to protect

counterparties, and if so, what are the

minimum thresholds;

■Cross default provisions;

■Termination payment terms (subordinate and/or

payout as lump sum or amortized over time); and

■Counterparty rating minimums and other credit

protection provisions, such as collateral require-

ments or third-party guarantees.

Oversight

Managing derivatives, such as interest rate swaps,

requires an ongoing commitment from the issuing

entity’s senior executives and governing body. All

senior management and officials—not just the chief

financial officer—should become familiar with the

risks and rewards of the derivatives. As part of a

swap policy, an issuer should delineate what

process it will follow to consider entering into

swaps and which positions have direct and indirect

oversight of the real-time management of swaps. In

terms of ongoing oversight, issuers should routinely

monitor swaps under current and forecasted interest

rate environments, in order to gauge potential cash

flow gains and losses as well as market opportunities

for voluntary terminations and restructurings.

Market valuations of derivatives should also be

routinely calculated.

Disclosure

Issuers should commit to continually disclose all

aspects of derivatives position in accordance with

GASB guidelines, or FASB, as applicable. Currently,

GASB’s 2003 Technical Bulletin (“2003-01-Disclosure

Requirements for Derivatives Not Reported at Fair

Value”) provides guidelines for adequate disclosure

of pertinent information related to derivatives. In

addition, at the time of a rating review, management

should be prepared to discuss the details of the

swap plan and plan of finance and state the current

and future economic viability of the swaps in addi-

tion to the likelihood of voluntary or involuntary

termination during the course of the current and

upcoming fiscal year.

Strategy

The issuer should outline the different types of

swaps or derivatives that would be included within

a swap plan; that is the types of structures that

could be considered when presenting an opportunity

for risk management (e.g., in which interest rate

environments) and how they should be used (e.g.

natural hedges, basis swaps or synthetic refundings,

rate locks, synthetic fixed and variable, etc.) in the

broader context of the capital financing plan. The

desirable capital structure of variable to fixed-rate

debt should also be determined as a percentage of

total debt outstanding (net variable exposure).

Management Check List

Addressing the following issues will strengthen the

swap management policy:

■Formal approval of written documents by the

issuer’s governing body;

■Swap risks identified and discussed in the context

of the issuer’s financing plans;

■Annual management review and discussion of

hedging strategies;

■Commitment to complete and comprehensive

disclosure of swaps in audited financial state-

ments above and beyond required GASB or

FASB parameters;

■Monitoring of swaps with semi-annual valuation

by a third party

■Policies on legal provisions, including optional

swap terminations, collateral, or swap insurance;

■Counterparty diversification or a minimum

ratings policy for counterparties; and

■A net variable rate exposure policy.

Net Variable Rate Debt Calculation

Standard & Poor’s believes that quantification of

both balance sheet and cash flow risks associated

with variable rate debt is necessary to properly

evaluate an issuer’s financial flexibility resources

when entering into swaps. The quantification

process includes determining net variable rate and

short-term debt. Once quantified, the overall credit

impact of variable rate debt and swaps can be fac-

tored into an issuer’s rating. This evaluation process

will be made on a case-by-case basis.

Net variable rate and short-term

debt exposure ratio

Standard & Poor’s monitors an issuer’s use of variable

rate debt as part of the ratings process through a

net variable interest rate exposure ratio, which

Cross Sector Criteria

36 Standard & Poor’s Public Finance Criteria 2007

(1) Cash flow projections as discussed under “Cash Flows.”

(2) Dbt Management Plan

(3) Swap Management Plan

(4) Swap legal documents:

■Bond Trust Indenture

■ISDA Master Agreement

■Schedule with Confirmation

Required Documentation For

Variable Rate Debt And Swaps